OPINION: Is there more life in equity markets?
But soothing words from bankers and politicians can go only so far; a pick-up in business prospects is required to justify further progress.
April saw tentative signs of improvement in the world’s largest and second-largest economies. US and Chinese business confidence surveys signalled a chirpier mood, while cyclically sensitive industries defied doom-mongers with solid profit reports and reasonable outlooks.
Corporate earnings expectations are very beatable, with the bar having been set low, amid heightened recession fears in December. First-quarter earnings growth for S&P 500 companies have been cut by 10 percentage points since July. Before the first quarterly reports started to trickle out in early April, earnings were predicted to fall by more than 4 percent.
This decline would have been the sharpest since the first quarter of 2016. US multinationals, with more than half their sales derived outside their home market, were expected to fare even worse with earnings dropping more than 11percent. To widespread relief, Wall Street’s worst fears would appear unfounded as with almost half of S&P 500 quarterly reports now out, earnings growth is tracking to be almost flat - down only 1percent.
Another positive is cautious investor positioning. Compared to December there is a lot less fear and markets are no longer technically oversold. However, it has been a “flowless” rally.
Equity funds have suffered outflows despite stock markets’ best start to the year since 1998. As such, there remains plenty of cash on the sidelines to redeploy.
What is the catalyst for further gains? An improving growth outlook is key. Specifically, we are closely watching developments in China. Encouragingly, the Chinese government is committing tax cuts and spending worth about $800billion. This fiscal boost exceeds the $600bn stimulus injected during the last slowdown in 2015/16. In addition, the Chinese central bank has cut the amount of cash banks have to hold in reserve. This surplus capital should eventually feed through to the economy via more lending.
Regardless of what happens this year, equities are a better long-term proposition relative to the meagre implied returns on investment grade bonds. A decade of central bank bond buying has distorted relative valuations. Since the 2007/8 global financial crisis, fixed-coupon US dollar bonds no longer pay investors a higher yield over equities to compensate for their lack of inflation protection. This makes the sustainable global growth businesses held in our client portfolios comparatively attractive.
With major central banks around the world showing a willingness to keep interest rates lower for longer and some evidence that global growth looks set to improve in the second half of the year, risk assets continued to enjoy a rebound in April.
However, as protectionism grows, and central banks focus on keeping asset prices buoyant, without creating inflationary bubbles, there remains little margin for policy error.
Bernard Drotschie is the deputy chief investment officer at Melville Douglas.